EUR/USD update (26th July 2012, 06:00)

EUR/USD and EUR/JPY were nicely supported in early European trade on comments from ECB member Ewald Nowotny.

Mr Nowotny commented that ‘there are pro arguments’ in favour of granting the ESM (European Stability Mechanism) a banking licence, which in turn could access cheap funds from the ECB and buy Spanish bonds in the secondary market, with the idea to drive down borrowing costs. These comments are extremely interesting given we feel granting a banking licence to the ESM is seen as one of two solutions to the European debt crisis or at least the symptoms, the other being changing the ECB’s mandate so that the ECB can print money and buy bonds to bring down yields.

While it is indeed positive that it seems the ECB is at least thinking about these steps, it is no way reflecting the wider central banks’ view, as it is only his personal view. Mr Nowotny should be listened to though, as he is seen as a bit of a visionary within the Bank, recently putting the argument out there that the deposit rate should be cut to zero well before the July action. It also seems as though the ECB is warming to new policy initiatives, where only recently we heard from Mario Draghi and ECB members Mr Knot and Mr Coure about the need for the ECB to overcome old taboos. A banking licence would require treaty change, and only back in December did we hear Mario Draghi saying the spirit of the Treaty should be respected; given Germany hasn’t even voted on the constitutionality of the ESM, there are still many hurdles to overcome. Still we will look at this positively in the sense that at least it is being debated and is interesting timing given the ECB meet next week. At least it gives us hope!

Spanish bonds reacted positively with the two-year bond yield dropping 72 basis points from a new era-high of 7.14%. With this is mind, and given next week’s event risk which includes the FOMC meeting, ECB meeting and US payrolls, we feel the downside in EUR/USD and EUR/JPY is probably limited in the short term. We are likely to see range trading, with EUR/JPY 94.14-96.71 and EUR/USD 1.2050 – 1.2257 (July 13 low).